# Amicus Curiae Brief — Department of Revenue of Ky. v. Davis

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0507%3A17

## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 2008
- **Citation:** 553 U.S. 328

## Text

nS

Supreme Court, US.
1 JUL 19 2007
on No. 06-666 OFFICE OF THE CLERK |
In the

Supreme Court of the United States

DEPARTMENT OF REVENUE OF KENTUCKY, ETAL.,
Petitioners,
Ve
GEORGE W. DAVIS and CATHERINE V. DAVIS,
Respondents.

On Writ of Certiorari to the Court of Appeals of Kentucky

BRIEF FOR THE STATES OF NORTH CAROLINA,
ALABAMA, ALASKA, ARIZONA, ARKANSAS,
CALIFORNIA, COLORADO, CONNECTICUT,

DELAWARE, FLORIDA, GEORGIA, HAWAII, IDAHO,
ILLINOIS, INDIANA, IOWA, KANSAS, LOUISIANA,
MAINE, MARYLAND, MASSACHUSETTS, MICHIGAN,
MINNESOTA, MISSISSIPPI, MISSOURI, MONTANA,
NEBRASKA, NEVADA, NEW HAMPSHIRE,

NEW JERSEY, NEW MEXICO, NEW YORK,
NORTH DAKOTA, OHIO, OKLAHOMA, OREGON,
PENNSYLVANIA, RHODE ISLAND, SOUTH CAROLINA,
SOUTH DAKOTA, TENNESSEE, TEXAS, UTAH,
VERMONT, VIRGINIA, WASHINGTON, WEST VIRGINIA,
WISCONSIN AND WYOMING
AS AMICI CURIAE IN SUPPORT OF PETITIONERS

ROY COOPER North Carolina Department
Attorney General of Justice

State of North Carolina Post Office Box 629
Christopher G. Browning, Jr.* Raleigh, N.C. 27602

Kay Linn Miller Hobart Telephone: (919) 716-6900

Gregory P. Roney

July 19, 2007 *Counsel of Record
(Additional Counsel Listed On Inside Cover)

TROY KING

Attorney General

State of Alabama

State House

11 S. Union Street
Montgomery, AL 36130
(334) 242-7300

TALIS J. COLBERG
Attorney General

State of Alaska

Post Office Box 110300
Diamond Courthouse
Juneau, AK 9981 |]
(907) 465-3600

TERRY GODDARD
Attorney General

State of Arizona

1275 West Washington
Phoenix, AZ 85007
(602) 542-4266

DUSTIN McDANIEL
Attorney General
State of Arkansas

200 Tower Building
323 Center Street
Little Rock, AR 72201
(800) 482-8982

T_T

EDMUND G. BROWN, JR.
Attorney General

State of California

1300 I Street, Suite 1740
Sacramento, CA 95814
(916) 445-9555

JOHN W. SUTHERS
Attorney General

State of Colorado

1525 Sherman Street
Seventh Floor

Denver, Colorado 80203
(303) 866-3052

RICHARD BLUMENTHAL
Attorney General

State of Connecticut

55 Elm Street

Hartford, CT 06141

(860) 808-5318

JOSEPH R. BIDEN, III
Attorney General

State of Delaware

Carvel State Office Building
820 N. French Street
Wilmington, DE 19801
(302) 577-8338

BILL McCOLLUM
Attorney General

State of Florida

The Capitol, PL 01
Tallahassee, FL 32399
(850) 414-3300

THURBERT E. BAKER ©

Attorney General

State of Georgia

40 Capitol Square, SW
Atlanta, GA 30334
(404) 656-3300

MARK J. BENNETT
Attomey General
State of Hawaii

425 Queen Street
Honolulu, HI 96813
(808) 586-1500

LAWRENCE WASDEN
Attomey General

State of Idaho
Statehouse

Boise, ID 83720

(208) 334-2400

LISA MADIGAN
Attorney General

State of Illinois

James R. Thompson Center
100 W. Randolph Street
Chicago, IL 60601

(312) 814-3000

STEVE CARTER

Attorney General

State of Indiana

Indiana Government Center
South, 5" Floor

402 West Washington Street

Indianapolis, IN 46204

(317) 232-6201

TOM MILLER

Attorney General

State of Iowa

Hoover State Office Bldg.
1305 E. Walnut

Des Moines, IA 50319
(515) 281-5164

PAUL MORRISON
Attorney General

State of Kansas

120 S.W. 10" Ave., 2nd FI.
Topeka, KS 66612

(785) 296-2215

CHARLES C. FOTI, JR.
Attorney General

State of Louisiana

Post Office Box 94005
Baton Rouge, LA 70804
(225) 326-6000

G. STEVEN ROWE
Attorney General
State of Maine

State House Station 6
Augusta, ME 04333
(207) 626-8800

DOUGLAS F. GANSLER
Attomey General

State of Maryland

200 Saint Paul Place
Baltimore, MD 21202
(410) 576-6300

MARTHA COAKLEY
Attorney General

State of Massachusetts
One Ashburton Place
Boston, MA 02108
(617) 727-2200

MICHAEL A. COX
Attorney General
State of Michigan
P.O. Box 30212
Lansing, MI 48909
(517) 373-1110

LORI SWANSON

Attorney General

State of Minnesota

102 State Capitol

75 Rev. Dr. Martin Luther
King, Jr. Boulevard

St. Paul, MN 55155

(651) 296-3353

JIM HOOD

Attorney General
State of Mississippi
Department of Justice
Post Office Box 220
Jackson, MS 37205
(601) 359-3680

JEREMIAH W. (JAY) NIXON
Attorney General

State of Missoun
Supreme Court Building
207 W. High Street
Jefferson City, MO 65101
(573) 751-3321

MIKE McGRATH
Attorney General

State of Montana
Justice Building

Post Office Box 201401
Helena, MT 59620
(406) 444-2026

JON BRUNING
Attorney General

State of Nebraska
State Capitol

Post Office Box 98920
Lincoln, NE 68509
(402) 471-2682

CATHERINE CORTEZ MASTO
Attorney General

State of Nevada

100 N. Carson Street

Carson City, NV 89701

(775) 684-1112

KELLY A. AYOTTE
Attorney General

State of New Hampshire
33 Capitol Street
Concord, NH 03301
(603) 271-1202

ANNE MILGRAM
Attorney General

State of New Jersey

R.J. Hughes Justice Complex
245 Market Street

Post Office Box 080
Trenton, NJ 08625

(609) 292-8740

GARY KING

Attorney General

State of New Mexico
Post Office Drawer 1508
Sante Fe, NM 87504
(505) 827-6000

ANDREW M. CUOMO
Attorney General

State of New York
Department of Law

The Capitol, 2nd Floor
Albany, NY 12224
(518) 474-7330

WAYNE STENEHJEM
Attorney General

State of North Dakota
State Capitol

~»>) E. Boulevard Avenue
Demark, ND 58505
(701) 328-2210

MARC DANN PATRICK LYNCH

Attorney General Attorney General

State of Ohio State of Rhode Island
30 E. Broad Street, 17th Floor 150 S. Main Street
Columbus, OH 43215 Providence, RI 02903
(614) 466-8980 (401) 274-4400

W.A. DREW EDMONDSON HENRY McMASTER
Attorney General Attomey General

State of Oklahoma State of South Carolina
313 N.E. 21st Street Rembert C. Dennis Office
Oklahoma City, OK 73105 Building

(405) 521-3921 Post Office Box 11549

Columbia, SC 29211-1549
(803) 734-3970

HARDY MYERS LAWRENCE E. LONG
Attorney Genera! Attorney General

State of Oregon State of South Dakota
1162 Court St. N.E. 1302 E. Hwy. 14, Suite 1
Salem, Oregon 97301 Pierre, SD 57501-8501
(503) 378-4732 (605) 773-3215

THOMAS J. CORBETT, JR. ROBERT E. COOPER, JR.

Attorney General Attorney General
State of Pennsylvania State of Tennessee
16th Floor, Strawberry Square 500 Charlotte Avenue
Harnsburg, PA 17120 Nashville, TN 37243

(717) 787-3391 (615) 741-5860

GREG ABBOTT
Attorney General

State of Texas

Capitol Station

Post Office Box 12548
Austin, TX 78711
(512) 463-2100

MARK L. SHURTLEFF
Attorney General

State of Utah

Utah State Capitol Complex
East Office Bidg., Suite 320
Salt Lake City, UT 84114
(801) 538-9600

WILLIAM H. SORRELL
Attorney General

State of Vermont

109 State Street
Montpelier, VT 05609
(802) 828-3173

BOB McDONNELL
Attorney General
State of Virginia

900 E. Main Street
Richmond, VA 23219
(804) 786-2071

ROBERT M. McKENNA
Attorney General

State of Washington

1125 Washington Street
Post Office Box 40100
Olympia, WA 98504
(360) 753-6200

DARRELL V. McGRAW, JR.
Attorney General

State of West Virginia

State Capitol, Room 26-E
Charleston, WV 25305
(304) §58-2021

J. B. VAN HOLLEN
Attorney General

State of Wisconsin

State Capitol, Suite 114E
Post Office Box 7857
Madison, WI] 53707
(608) 266-1221

PATRICK J. CRANK
Attorney General

State of Wyoming

123 Capitol Building
Cheyenne, WY 82002
(307) 777-7841

TABLE OF CONTENTS

TAREE GP AUPE RIEEED oc ccc cccccccccccccccees inl
INTERESTS OF AMICI CURIAE ...........----555. ]
SUMMARY OF ARGUMENT .............---4-e05- 2
ARGUMENT ........ kL wundeneees Ghecanensostesees +

I. A STATE LAW PROVIDING INCOME TAX
EXEMPTIONS FOR INTEREST EARNED ON
BONDS ISSUED BY THE STATE AND ITS
POLITICAL SUBDIVISIONS, BUT NOT
INTEREST EARNED ON BONDS ISSUED BY
OTHER STATES AND THEIR POLITICAL
SUBDIVISIONS, DOES NOT DISCRIMINATE
AGAINST INTERSTATE COMMERCE. ....... 5

A. This Practice Is Longstanding and
TEED. Ge cb evcvevesadetcvedececess 6

B. The Widespread Practice by States of
Exempting Their Own Bonds, While
Taxing the Bonds of Sister States, Is
Directed Toward Legitimate Goals
Unrelated to Protectionism. ............... 8

C. The States’ Treatment of Interest Earned
on State and Local Bonds Is Not
Discriminatory Within the Meaning of the
Dormant Commerce Clause............... 12

1. AS A SELLER OF BONDS, KENTUCKY
STANDS AS A MARKET PARTICIPANT. .... 14

1]

lll. THE RULE ADOPTED BY THE LOWER
COURT WOULD HAVE DEVASTATING
EFFECTS ON THE STATES’ FISC AND THE
BOND MARKET, AND REFLECTS A
DECISION BETTER LEFT TO CONGRESS. .. 16

SURED, 6 enc w on cwscobascdeccicvevcnsaccos til

iil

TABLE OF AUTHORITIES

FEDERAL CASES
Bonaparte v. Tax Court, 104 U.S. 592 (1881)...... 6, 7,13

| Boston Stock Exch. v. State Tax Comm'n,
ED 6 bcs dewieveesecceenees 11, 22
Fulton Corp. v. Faulkner, 516 U.S. 325 (1996) ..... 16, 18

Gen. Motors Corp. v. Tracy,

pit & se 0), ee 12, 13, 14, 19, 20
Gibbons v. Ogden, 22 U.S. 1 (1824) ...........00005. 22

Nat’l Private Truck Council v. Okla. Tax Comm'n,
515 U.S. 582 (1995) ...... SP ae 4

Nat'l Bank v. County of Yankton,
Fe ED CEE Se enscodkonvecedesogsovecss 22

New Energy Co. v. Limbach, 486 U.S. 269 (1988) ... 15, 16

Northwest Airlines, Inc. v. Minnesota,
nn ost keccduidededdateaees 19, 20

Quill Corp. v. North Dakota, 504 U.S. 298 (1992) ...... 20

Reeves, Inc. v. Stake, 447 U.S. 429 (1980) ... 11, 14, 15, 22

Trinova Corp. v. Michigan Dep't of Treasury,
PE ond pa nceeseuanead onsiuees 11

iV

United Haulers Ass'n v. Oneida-Herkimer Solid Waste

Memt. Auth., 127 S. Ct. 1786 (2007) ......... 3,5, 12
White v. Mass. Council of Constr. Emplovees,
“Ga SEE 8d hse toe evetscscuekasa ~o ie
Wilson v. McNamee, 102 U.S. 572 (1880) ............. 20
Wisconsin v. J.C. Penney Co., 311 U.S. 435 (1940) ...... 4

STATE CASES

Coley v. State, 631 §.E.2d 121 (N.C. 2006)............ 19
County of Cabarrus v. Tolson,

610 S.E.2d 443 (N.C. Ct. App. 2005) ............. 19
Dunn v. State, 635 $.E.2d 604 (N.C. Ct. App. 2006),

disc. review granted, 361 N.C. 351 (2007)......... 17
Goldston v. North Carolina,

Se ee a ED 0c obedeexitsecdesncds 19
Laura v. Droll, 187 N.W. 876 (Neb. 1922) ............. 9
Smith v. State, 507 §.E.2d 28 (N.C. 1998) ............. 18

FEDERAL MATERIAL

IRs fd cccdGedeedeceveesveenes seeds 22
Pub. L. 86-272, 73 Stat. 555 (1959) ...........002eeee 20
S. Rep. No. 91-552 (1969),

reprinted in 1969 U.S.C.C.A.N. 2027 ............ 21
H.R. Rep. No. 88-1480 (1964) .. 0.0.0... eee eee eee 21
H.R. Rep. No. 89-952 (1965) .........ccccccccvceees 21
H.R. Rep. No. 91-413 (1969),

reprinted in 1969 U.S.C.C.A.N. 1645 .........45. 21

STATE MATERIAL

Alabama

Ala. Code § 40-18-14(3)(f) (2003) ..........-0558. 7
Arizona

Ariz. Rev. Stat. Ann. § 43-1021(3) (Supp. 2006)..... 7
Arkansas

Ark. Code Ann. § 26.51-404(b)(5) (1997) .......... 7

I MEE oi dcocteneseeus veneeneseeoes 6
California

Cal. Gov’t Code § 99016 (Deering 2007).......... 17

Cal. Rev. & Tax. Code § 17133 (West 2004) ........ 7
Colorado

Colo. Rev. Stat. § 39-22-104(3)(b) (2006) .......... 7

vi

Connecticut

Conn. Gen. Stat. Ann. § 12-701(a)(20)(A)(i),(B)(vil)

POPES, CED incesc cu cvccscsewsenwnns's 7

Delaware

Del. Code Ann. tit. 30, § 1106(a)(1) (1997) ......... 7

pi RE eer ere res 6
Georgia

Ga. Code Ann. § 32-10-49 (2007) ............... 17

Ga. Code Ann. § 48-7-27(b)({1 (A) (2005) .......... 7
Hawaii

A om Ee SE) error 7

See. TAU. BAAR. B SFeL DE Teeee coc ccc cc vensscvces 7

Haw. Rev. Stat. § 235-7(a)(5), (a)(6), (b)(2) (1993)... 7

PSO] Plmwelt Sees. LAWS 1 ow wc cece ee cccsceess 6, 21
Idaho

Idaho Code § 63-3022M(1) (2007) ................ 7

Idaho Code § 63-3022M(3)(b) (2007) ............. 7
Indiana

Ind. Code Ann. § 6-3-1-3.5

CRGEPCUIND TU, PD ow cccecescececens 7,8

Kansas

Kan. Stat. Ann. § 79-32,117(b)(i) (Supp. 2006) ...... 7
Kentucky

he § oy, Perro error ree TT Tere eT 17

Ky. Rev. Stat. Ann. § 58.580 (West Supp. 2006) .... 17
Ky. Rev. Stat. Ann. § 141.010(10)(c)

(West Supp. 2006) ............. aS) ane 7
PL EO was eked wan seta vinvs eee saeeees 6

Vii

Louisiana
La. Rev. Stat. Ann. § 47:48 (2001) ................ 7
La. Rev. Stat. Ann. § 47:293(6)(a), (b)
i cen ee ehwiehas oes ese eee oa we 7

Maine
Me. Rev. Stat. Ann. tit. 36, § 5122(1)(A)
ES Perr ree 7

Maryland
Md. Code Ann., Tax-Gen. § 10-204(b)
PPTL TTT TTT TTT 7
Md. Code Ann., Tax-Gen. § 10-305(d)
(LexisNexis Supp. 2006) ......cccccccccccees 7

Massachusetts
Mass. Gen. Laws Ann. ch. 62, § 2(a)(1)(A)
EE Soo cke dese eenekéeusecoas 7
i inn nate unekecehneen sue 6

Michigan
Mich. Comp. Laws § 2V6.30(1)(a)
PP TT TTT ee Te 7

Minnesota
Minn. Stat. Ann. § 290.01(19a)(1)(1) (West 1999) .... 7

Mississippi
Miss. Code Ann. § 27-7-15(4)(d) (Supp. 2006) ...... 7

Missouri
Mo. Ann. Stat. § 143.121(2)(b) (West Supp. 2007) ... 7

Vill

Montana
Mont. Code Ann. § 15-30-111(1)(a)(i) (2005)
Mont. Code Ann. § 15-30-111(2)(a)(i) (2005)

Nebraska
Neb. Rev. Stat. § 77-2716(1)(a), (c) (Supp. 2006)

New Hampshire
N.H. Rev. Stat. Ann. § 77:4(I) (Supp. 2006)
PON PS MEE OE occ bho cu vane cevnnecesesevus

New Jersey
N.J. Stat. Ann § 54A:6-14 (West 2002)

New Mexico
N.M. Stat. § 7-2-2(B)(3), (V) (2005) .......00... 7,8
New York
N.Y. Pub. Auth. Law § 372 (McKinney 2004) ......
N.Y. Tax Law § 612(b)(1)
7,8

(McKinney Supp. 2006)
SO eo EE EE ou oooh kode acne uv evawecns

North Carolina
N.C. Gen. Stat. § 105-134.6(c)(1) (2007)
SO eis MO INT gg ince u vedmceccwnns

North Dakota
N.D. Cent. Code § 57-38-01.2(1)(g) (2005)

eS 8. ee e2Beseersevseeseneses een & OOo 6 Oo 6

Ohio
747.01(A\(1)
7

Ohio Const. art. VII
Ohio Rev. Code Ann. § 5
(LexisNexis Supp. 20

ix

Oklahoma
Okla. Stat. Ann. tit. 68, § 2358 (A)(1)
PPE TD vc cccccncceccccesuceees 7,8
Okla. Stat. Ann. tit. 68, § 2358.5A (A)
EE cteccdmcrinweaseknanes 7,8
Oregon
Or. Rev. Stat. § 316.680(2)(a) (2005) ............ 7,8
Pennsylvania
72 Pa. Stat. Ann. § 7302 (West Supp. 2007) ...... 7,8
72 Pa. Stat. Ann. § 7303(a)(6)
EL ic nade his shaun ewe evade 7,8
72 Pa. Stat. Ann. § 9901 (West Supp. 2007) ...... 7,8
Rhode Island

R.I. Gen. Laws § 44-30-12(a), (b)(1) (Supp. 2006) . 7, 8

South Carolina
S.C. Code Ann. § 12-6-1120(1)

(20ee G BURR. FOGG) ww ccc ccccccccccccs 7,8
ER RS an ee ee 6
Tennessee

Tenn. Code Ann. § 67-2-104(e)(1) (Supp. 2006) ... 7, 8

Vermont
Vt. Stat. Ann. tit. 32, § 5811(18)(A)(i)d)
(Supp. 2006) ...... CCAR EHRAOD RA Wewe eset 7,8
Virginia
Va. Code Ann. § 15.2-5361 (2007) .............. 17

Va. Code Ann. § 58.1-322(B){1) (Supp. 2007) .... 7,8
Ne a 6

West Virginia
W. Va. Code § 11-21-12(b)(1)
(LexisNexis Supp. 2007) ........... Lee ee 7,8

SECONDARY SOURCES

Robert S. Amdursky & Clayton P. Gillette,
Municipal Debt Finance Law: Theory
Soe BR err 9

Scott K. Attaway, Note, The Case for Constitutional
Discrimination in Taxation of Out-of-State
Municipal Bonds, 76 B.U. L. Rev. 737 (1996) ....... 8

Dwight Denison, Merl Hackbart & Michael Moody,
Davis v. Department of Revenue: A Preliminary
Impact Assessment |} (Inst. for Federalism &

Intergovernmental Relations Working Papers
Sens, Paper No. 2007-03, 2006) .............. 2,19

The Federalist No. 81 (Alexander Hamilton)
(Arlington House 1965) .................005: l,@e

Michael J. Graetz & Deborah H. Schenk, Federal Income
Taxation: Principles and Policies (Sth ed. 2005) ....9

Christopher Kirkpatrick, Eas/ev Declares Fiscal
Emergency, Durham Herald Sun,
St SE eG ae ayaa ake a eee de wes 48 oh 8 18

Robert Lamb & Stephen P. Rappaport, Municipal Bonds:
The Comprehensive Review of Tax Exempt
Securities and Public Finance (1980) ............ 10

x1

Timothy P. Noonan & David Martin, U.S. Supreme
Court's Decision to Hear Municipal Bond
Case Raises Constitutional, Procedural
Questions, 44 State Tax Notes 969 (2007) ..... La

Edward Yorio, Equity, Efficiency and the Tax Reform
Act of 1986, 55 Fordham L. Rev. 395 (1987) ....... 10

Edward Zelinsky, For Realization: Income T. axation, |
Sectoral Accretionism, and the Virtue of Attainable
Values, 19 Cardozo L. Rev. 861 (1997) ........... 10

]
INTERESTS OF AMICI CURIAE

For nearly a century, States have exempted interest on
their own bonds from income taxation while taxing interest
income on the bonds of sister States. The overwhelming
majority of States have a taxation system comparable to

~” “Kentucky’s. A decision by this Court proscribing this

longstanding practice would injure the States in several distinct
and important ways.

The States’ sovereign interest in controlling their finances
and debt service was recognized as far back as The Federalist
No. 81, where Alexander Hamilton wrote that the Constitution
did not “divest[{]” the States “of the privilege of paying their
own debts in their own way.” The Federalist No. 81, at 488
(Alexander Hamilton) (Arlington House 1965). When the
Commerce Clause is wrongly construed so as to unduly
interfere with the ability of elected state officials to perform
traditional state functions, the sovereignty of ail States is
adversely affected.

If the decision of the Kentucky Court of Appeals is
affirmed, the 38 States that exempt their own bonds from state
income taxation, while taxing the bonds of sister States, will
face staggering potential liability. The amount at issue for
even a single tax year will significantly impact state budgets.
New York estimates that it will face claims of $200 million for
past tax years and will lose annual revenue of approximately
$70 million should the decision below be affirmed. The
liability will be even greater in those States where challenges
were filed several years ago. In North Carolina, for example,
a class of taxpayers is seeking the refund of all income taxes
paid on out-of-state bonds since 2001.

Finally, all States have a substantial interest in this appeal
given its potential impact on the overall bond market. An
affirmance of the Kentucky Court of Appeals would put the
“bond market into an unprecedented upheaval.” Timothy P.

2

Noonan & David Martin, U.S. Supreme Court's Decision to
Hear Municipal Bond Case Raises Constitutional, Procedural
Questions, 44 State Tax Notes 969 (2007). The bond market
historically has reacted negatively to change, espectally
dramatic change. Any instability in the market stands to
devalue substantially bonds held by the residents of all 50
States. Additionally, some States could see increases in their
costs of borrowing. See Dwight Denison, Merl Hackbart &
Michael Moody, Davis v. Department of Revenue: A
Preliminary Impact Assessment 11 (inst. for Federalism &
Intergovernmental Relations Working Papers Series,
Paper No. 2007-03, 2006), available at
http://www.ifigr.org/publication/index.html (follow “No. 2007-
03” hyperlink) (stating that elimination of state tax exemption
“could have a dramatic impact upon municipal bond yields”).
For this reason, all of the Amici States (regardless of their
taxation system) have a strong interest in ensuring that the
decision below ts reversed.

SUMMARY OF ARGUMENT

The practice by States of exempting their own bonds from
taxation, while taxing the interest on bonds of other States, is
longstanding, widespread and well-known by Congress. This
practice serves legitimate and important state interests. States
exempt interest on their own bonds from income taxation
because it allows them to lower their financing costs, improve
their credit ratings and build more schools, hospitals, libraries
and roads. Bond purchasers are willing to accept a lower
interest rate for a tax-exempt bond than for a comparable
taxable bond because they are motivated by the net return on
investment (i.¢., the income stream produced by the bond less
taxes imposed on this income). (

Tax exemption of municipal bonds is not without its costs.
When a State exempts a bond from taxation, 1t forgoes a stream

3

of tax revenue that it would otherwise be entitled to receive
over the life of the bond. States do not give up this income
stream lightly. Rather, they generally forgo this income stream
only when they know that what they are getting in return (more
favorable interest rates) will benefit the State. Kentucky, like
_ virtually every other State, exempts only its own bonds from
taxation. This ensures that the tax revenue Kentucky is
forgoing benefits the building of schools, hospitals, roads and -
other infrastructure in the State ~ the same use those taxes
would have served had they been collected over the life of the
bond. Kentucky’s taxation system therefore serves legitimate
state interests, unrelated to protectionism.

Kentucky’s practice of exempting only Kentucky bonds
from state income taxation helps state and local governments
fulfill their essential functions; it does not favor private
industry. Because this taxation system does not give in-state
private industry a competitive advantage over out-of-state
interests, it withstands scrutiny under United Haulers Ass'n v.
Oneida-Herkimer Solid Waste Mgmt. Auth., 127 S. Ct. 1786,
1790 (2007).

Importantly, Kentucky is not similarly situated to other
entities selling bonds in Kentucky. First, no other bond issuer
is in the business of providing public works within the State of
Kentucky. Second, only Kentucky can forgo collecting income
tax upon its bonds and, by doing so, ensure that the tax revenue
that Kentucky is forgoing will still serve to facilitate the
building of schools, hospitals and roads in Kentucky.
Kentucky is therefore unique among other entities selling
bonds within Kentucky. The Kentucky Court of Appeals
therefore erred in concluding that the Kentucky taxation system
violates the dormant Commerce Clause.

The lower court also erred in concluding that Kentucky 1s
not a market participant. When States act as market
participants, their actions ave free from dormant Commerce
Clause analysis. Here, Kentucky is merely agreeing to forgo

4

collecting a tax in order to obtain more favorable terms for a
product that Kentucky itself is selling in the marketplace.
Kentucky therefore is a market participant.

If the decision of the Kentucky Court of Appeals is upheld,
the impact on States and bondholders will be devastating.
Given Congress’ implicit approval of this longstanding,
widespread and well-known taxation practice, any change
should be made by Congress, not the courts.

ARGUMENT

This Court has “long recognized that principles of
federalism and comity generally counsel that courts should
adopt a hands-off approach with respect to state tax
administration.” Nat'l Private Truck Council v. Okla. Tax
Comm'n, 515 U.S. 582, 586 (1995); see also Wisconsin v. J.C.
Penney Co., 311 U.S. 435, 444 (1940) (recognizing that States
should be free to pursue their own fiscal and taxing policies).
Those principles apply with particular force in this case. For
nearly a century, States have exempted from taxation the
interest earned on their own bonds, while taxing interest
income from the bonds of other States. This practice has been
acknowledged and countenanced by Congress and this Court.
To suddenly strike it down in the name of the dormant
Commerce Clause would be a stark departure from tradition,
one with potentially devastating consequences for the States.
This Court’s Commerce Clause jurisprudence requires no such
result.

To the contrary, state laws that favor local government
serve legitimate, non-protectionist interests and are therefore
consistent with the Commerce Clause, under both the ant-
discrimination and market participant lines of cases. This
Court has also recognized that congressional acquiescence in
longstanding state practices militates in favor of sustaining
such practices. Kentucky's tax system should be upheld.

5

I. A STATE LAW PROVIDING INCOME TAX
EXEMPTIONS FOR INTEREST EARNED ON
BONDS ISSUED BY THE STATE AND ITS
POLITICAL SUBDIVISIONS, BUT NOT INTEREST
EARNED ON BONDS ISSUED BY OTHER STATES
AND THEIR POLITICAL SUBDIVISIONS, DOES

' NOT DISCRIMINATE AGAINST INTERSTATE
COMMERCE.

In United Haulers Ass'n v. Oneida-Herkimer Solid Waste
Mgmt. Auth., 127 S. Ct. 1786, 1795-96 (2007), this Court
rejected the charge that a “law[] favoring local government”
was facially discriminatory within the meaning of the dormant
Commerce Clause and therefore invalid. The Court recognized
that the “government is vested with the responsibility of
protecting the health, safety, and welfare of its citizens,” and
that “[t]hese important responsibilities set state and local
government apart from typical private business.” Jd. at 1795.
The Commerce Clause was not intended to, and has never been
understood to, stand in the way of the States directly engaging
in those activities — be they processing garbage, running
prisons, financing capital improvements or constructing roads.

Laws favoring local government are consistent with the
Commerce Clause because local government is not “similarly
situated” to potential competitors and because “[IJaws favoring
local government . . . may be directed toward any number of
legitimate goals unrelated to protectionism.” Jd. at 1796.
Courts “should be particularly hesitant to interfere with [a
government’s] efforts under the guise of the Commerce
Clause” where the government is engaged in what “is both
typically and traditionally a local government function.” /d.
(citation and quotation marks omitted).

All of these considerations apply with full force in this
case and support upholding Kentucky’s tax system. When
States sell bonds to pay for hospitals, roads, prisons and other

6

important capital projects — and exempt the interest on those
bonds from state income taxes to lower the bonds’ effective
cost to the State — they are engaging in a traditional
government activity that serves core sovereign functions. Out-
of-state governmental bond issuers are not similarly situated to
the taxing State and its political subdivisions, and legitimate
interests are served by the States’ common practice of
exempting the interest earned on their own bonds from
taxation, but not extending that exemption to bonds issued by
other States.

A. This Practice Is Longstanding and Widespread.

The practice by States of exempting their own bonds trom
taxation, while taxing the bonds of sister States, dates back to
the beginning of state income tax statutes. See, e.g., 1919 N.Y.
Laws 1641-42; 1921 N.C. Sess. Laws 208; 1921 Mass. Acts
616; 1923 N.H. Laws 78; 1926 Va. Acts 961; 1927 S.C. Acts
7; 1929 Ark. Acts 585; 36 Del. Laws 37 (1929); 1936 Ky. Acts
70; see also 1901 Hawaii Sess. Laws 31-32 (territorial practice
that continued following statehood).

This longstanding practice is grounded in this Court’s
decision in Bonaparte v. Tax Court, 104 U.S. 592 (1881). In
Bonaparte, this Court held that New York, by exempting its
own bonds from taxation, could not compel Maryland to
refrain from taxing those bonds when acquired by a Maryland
resident. In rendering its decision, this Court declared:

[1]f a State could protect its securities from taxation
everywhere, it might succeed in borrowing money at
reduced interest; but, inasmuch as it cannot secure
such exemption outside its own jurisdiction, it is
compelled to go into the market as a borrower, subject
to the same disabilities in this particular as

j

individuals... . [T]he States are left free to extend
the comity which is sought, or not, as they please.

Id. at 595. With this Court’s imprimatur, and the longstanding
acquiescence of Congress, state legislatures have enacted and
enforced taxation systems for a hundred years with the belief
that whether a State exempts the bonds of » «ster State is an
issue of comity that may be “extend{ed], or not, as [States]
please.” Jd.

This historical practice by States of only exempting their
own bonds from taxation continues today. Virtually all States
that have a state income tax exempt their own bonds, but tax
the bonds of sister States.’ As reflected by this nearly universal

' Ala. Code § 40-18-14(3)(f) (2003); Ariz. Rev. Stat. Ann.
§ 43-1021(3) (Supp. 2006); Ark. Code Ann. § 26.51-404(b)(5)
(1997); Cal. Rev. & Tax. Code § 17133 (West 2004); Colo. Rev.
Stat. § 39-22-104(3)(b) (2006); Conn. Gen. Stat. Ann.
§ 12-701(a)(20)(A)(i), (B)(vii) (West Supp. 2007); Del. Code Ann.
tit. 30, § 1106(a)(1) (1997); Ga. Code Ann. § 48-7-27(b)(1)(A)
(2005); Haw. Rev. Stat. §§ 39-11, 47-13, 235-7(a)(5), (a)(6), (b)(2)
(1993); Idaho Code Ann. § 63-3022M(1), -3022M(3)(b) (2007);
Kan. Stat. Ann. § 79-32,117(b)(i) (Supp. 2006); Ky. Rev. Stat. Ann.
§ 141.010(10)(c) (West Supp. 2006); La. Rev. Stat. Ann. §§ 47:48
(2001), 47:293(6)(a), (b) (Supp. 2007); Me. Rev. Stat. Ann. tit. 36,
§ 5122(1)(A) (Supp. 2006); Md. Code Ann., Tax-Gen. §§ 10-204(b),
10-305(d) (LexisNexis Supp. 2006); Mass. Gen. Laws Ann. ch. 62,
§ 2(a)(1)A) (West Supp. 2007); Mich. Comp. Laws Ann.
§ 206.30(1)(a) (West Supp. 2007); Minn. Stat. Ann.
§ 290.01(19a)(1)(i) (West 1999); Miss. Code Ann. § 27-7-15(4)(d)
(Supp. 2006); Mo. Ann. Stat. § 143.121(2)(b) (West Supp. 2007);
Mont. Code Ann. § 15-30-111(1)(a)(i), (2)(a)(i) (2005); Neb. Rev.
Stat. § 77-2716(1)(a), (c) (Supp. 2006); N.H. Rev. Stat. Ann.
§ 77:4(1) (Supp. 2006); N.J. Stat. Ann. § 54A:6-14 (West 2002);

8

practice and by the submission of this amici brief on behalf of
49 States in support of Kentucky, “the entities which
supposedly suffer by discriminatory taxation of municipal bond
income — the states themselves — have never challenged the
practice[, and] have almost uniformly adopted this method of
subsidizing local public works bonds.” Scott K. Attaway,
Note, The Case for Constitutional Discrimination in Taxation
of Out-of-State Municipal Bonds, 76 B.U. L. Rev. 737, 767
(1996).

B. The Widespread Practice by States of Exempting
Their Own Bonds, While Taxing the Bonds of
Sister States, Is Directed Toward Legitimate Goals
Unrelated to Protectionism.

1. To understand why States do not extend the tax
exemption to bonds issued by other States, it is helpful to
understand why States grant the exemption to their own bonds.

N.M. Stat. § 7-2-2(B)(3), (V) (2005); N.Y. Tax Law § 612(b)(1)
(McKinney Supp. 2006); N.C. Gen. Stat. § 105-134.6(c)(1) (2007);
N.D. Cent. Code § 57-38-01.2(1)(g) (2005); Ohio Rev. Code Ann.
§ 5747.01(A)(1) (LexisNexis Supp. 2007); Okla. Stat. Ann. tit. 68,
§§ 2358 (A){1), 2358.5A(A) (West Supp. 2007); Or. Rev. Stat.
§ 316.680(2)(a) (2005); 72 Pa. Stat. Ann. §§ 7302, 7303(a)(6),
9901 (West Supp. 2007); R.I Gen. Laws § 44-30-12(a), (b)(1)
(Supp. 2006); S.C. Code Ann. § 12-6-1120(1) (2000 & Supp. 2006);
Tenn. Code Ann. § 67-2-104(e)(1) (Supp. 2006); Vt. Stat. Ann. tt.
32, § S811¢18)A)G)UD (Supp. 2006); Va. Code Ann.
§ 58.1-322(B)(1) (Supp. 2007); W. Va. Code Ann.
§ 11-21-12(b)(1 (LexisNexis Supp. 2007); bur see Ind. Code Ann.
§ 6-3-1-3.5 (LexisNexis Supp. 2006) (extending the exemption to
interest earned on bonds issued by governmental entities outside

Indiana).

9

As an initial matter, bond issuances are essential for States to
provide needed services to their residents. Not only do they
allow States to undertake necessary capital improvements
without having to impose exorbitant taxes, they also allow
States to spread the cost of the project over its life. Robert S.
Amdursky & Clayton P. Gillette, Municipal Debt Finance
Law: Theory and Practice § 1.1.3, at 10-11 (1992). Thus,
bond issuances ensure that the cost of the State’s capital
improvements will be distributed fairly among taxpayers over
the life of those improvements.

The tax exemption of bonds allows state and local
governments to pay lower interest rates compared with rates
paid on taxable corporate bonds of equal risk and maturity. See
Michael J. Graetz & Deborah H. Schenk, Federal Income
Taxation: Principles and Policies 215-16 (5th ed. 2005). A
rational bond purchaser takes into account the total cost of the
bond (i.e., the original purchase price less the taxes that will
have to be paid on it). Laura v. Droll, 187 N.W. 876, 878
(Neb. 1922) (“It is self-evident that an investor is concerned
mainly with the net returns upon his investment, and if the state
or its municipalities issues a security drawing a certain rate of
interest, and at the same time taxes the owner of the security a
given rate, his net return is the difference between the amount
of taxes paid thereon and the amount of interest received.”).

If a bond is exempt from taxation, the potential purchaser
will be willing to pay more for the bond (or accept a lower
interest rate). Thus, when a State, such as Kentucky, sells a
bond in the marketplace, it can either: (1) tax the income from
that bond over time or (2) exempt the bond from taxation and
thereby obtain a more favorable interest rate. Instead of
collecting taxes on its bonds over the terms of the bonds and
then remitting these tax payments to the specific projects being
financed, Kentucky has effectively reinvested these taxes back

10

into the projects at the outset by obtaining more favorable
interest rates when the bonds are issued.’

The tax exemption not only allows States to obtain more
favorable financing terms, it also gives States the option of
borrowing greater sums without jeopardizing their credit
ratings. A State’s credit rating directly affects the State’s
borrowing costs. If a State is unable to maintain an acceptable
credit rating, its borrowing costs will become prohibitively
high. See Robert Lamb & Stephen P. Rappaport, Municipal
Bonds: The Comprehensive Review of Tax Exempt Securities
and Public Finance 52 (1980). By exempting its own bonds
from taxation, a State can lower its borrowing cost and,
consequently, borrow a greater amount without jeopardizing its
credit rating.

All told, the tax exemption of bonds is an indispensable
tool in ensuring the States’ fiscal needs. States have chosen to
exempt their own bonds from taxation because it allows them
to lower their borrowing costs and to increase the amount of
money available to build schools, hospitals and roads.

> Thus, with each debt-service payment, Kentucky is collecting
an implicit tax on Kentucky bonds in lieu of the explicit tax that
Kentucky collects on the bonds of other States. See Edward
Zelinsky, For Realization: Income Taxation, Sectoral Accretionism,
and the Virtue of Attainable Values, 19 Cardozo L. Rev. 861, 912
(1997) (stating that “the owners of municipal bonds .. . pay an
implicit tax in the form of higher purchase prices and lower rates of
return”); Edward Yorio, Equity, Efficiency and the Tax Reform Act
of 1986, 55 Fordham L. Rev. 395, 398 (1987) (“It is generally
acknowledged that the rate of return on [tax-exempt] bonds is lower
than the rate of return on comparable, fully-taxable investments of
equivalent risk. To the extent of the difference between those rates
of return, the investor is in effect paying an ‘implicit tax.*”).

== = v ——— ee =? CO A Ale ae le Ae “ie la ill. _—enllla

1]

2. Kentucky, like almost every other State in the Union,
has concluded that the tax exemption for interest income
should not be extended to its sister States’ bonds. There are
sound and sensible reasons for this decision. When Kentucky
exempts its bonds from taxation, it is sacrificing future tax
revenues from those bonds so that more money can be invested
in Kentucky schools now. If Kentucky were to exempt the
bonds of other States from taxation, it would be giving up state
income taxes without any corresponding benefit to the
construction of public works in Kentucky. Thus, granting a
tax exemption to bonds issued by Kentucky and its
subdivisions furthers the State’s legitimate interests. Granting
a tax exemption for out-of-state bonds does not. Kentucky
should not be forced to forgo state tax revenues to fund the
construction of schools in other States. See Reeves, Inc. v.
Stake, 447 U.S. 429, 442 (1980) (concluding that dormant
Commerce Clause does not preclude a State from “restricting
to state residents the enjoyment of state educational
institutions, energy generated by a state-run plant, police and
fire protection, and agricultural improvement and business
development programs”). Although Kentucky has a core
sovereign interest in the exercise of its borrowing, spending
and taxing powers, Kentucky has no stake in the price of other
States’ bonds and in the trade-off that other States make
between collecting funds sooner rather than later.

This Court has stressed that the Commerce Clause does
not “prevent the States from structuring their tax systems to
encourage the growth and development of intrastate commerce
and industry.” Boston Stock Exch. v. State Tax Comm'n, 429
U.S. 318, 336 (1977). In fact, it is “a laudatory goal in the
design of a tax system to promote investment that will provide
jobs and prosperity to the citizens of the taxing State.” Trinova
Corp. v. Michigan Dep’t of Treasury, 498 U.S. 358, 385
(1991). Kentucky — and the other 37 States with similar tax
systems — are merely seeking to effectuate those objectives.

12

C. The States’ Treatment of Interest Earned on State
and Local Bonds Is Not Discriminatory Within the
Meaning of the Dormant Commerce Clause.

In United Haulers, the Court recognized that “it does not
make sense to regard laws favoring local government and laws
favoring local private industry with equal skepticism.” 127 S.
Ct. at 1795. This is because “laws favoring local government”
typically further legitimate, non-protectionist interests and
because local government is not “similarly situated” to
potential competitors. /d. States furnish public services to
their citizens; no other entity competes with a State to
undertake that traditional obligation. All this holds true with
respect to States’ treatment of interest earned on government
bonds.

Kentucky’s taxation system helps state and local
governments fulfill their essential functions; it does not favor
private industry. The system does not give any private industry
based in Kentucky a competitive advantage over private
industries located out-of-state. The statutes at issue achieve a
single and simple purpose — the State is allowed to give up
future tax revenue to obtain better financing terms on the bonds
itissues. These bonds then help finance capital improvements
necessary to the well-being of the State’s residents. Because
Kentucky’s taxation system “treat[s] in-state pnvate business
interests exactly the same as out-of-state ones,” it does not
violate the dormant Commerce Clause. /d. at 1797.

Moreover, the dormant Commerce Clause is focused on
the differential treatment of entities that are substantially
similar. “‘[AJny notion of discrimination assumes comparison
of substantially similar entities.’” Jd. at 1795 (quoting Gen.
Motors Corp. v. Tracy, 519 U.S. 278, 298 (1997)). Because
Kentucky is not substantially similar to other bond issuers,
Kentucky’s practice is not discriminatory.

13

No other State is in the business of providing public works
within the State of Kentucky. Additionally, Kentucky is the
only State that can agree to forgo the payment of taxes that
would otherwise be due to the Kentucky Treasury and thereby
obtain better financing terms for infrastructure to be built in
Kentucky. Kentucky stands in the unique position of being
both the seller and the tax collector with respect to its bonds.
No other State stands in this same position with respect to
Kentucky state taxes. Consequently, Kentucky is not similarly
situated for Commerce Clause purposes with other issuers
selling their bonds in Kentucky.

This is precisely the lesson of Bonaparte. The Court
recognized that because a State bond issuer “cannot secure
such an exemption outside of its own jurisdiction, it is
compelled to go into the market as a borrower, subject to the
same disabilities in this particular as individuals.” 104 U.S. at
595. When another State seeks to sell bonds to Kentucky
residents, it does not do so as a sovereign governing those
residents. It does so as an economic actor trying to convince
Kentucky residents that investing in its bonds would be wiser
than investing in, say, IBM stock. The relationship between
Kentucky and its residents — in general and specifically with
respect to the sale and tax treatment of its bonds — is far
different. Kentucky stands in the unique position of being the
seller, tax collector and spender with respect to its bonds.

General Motors cements the point. In that case, the Court
was faced with a challenge to Ohio’s taxation system on
natural gas sold within the State. Although Ohio imposed a
sales and use tax on natural gas, Ohio excepted regulated
public utilities from this tax. Thi: Court held that Ohio’s
taxation system did not violate the dormant Commerce Clause
because regulated public utilities were not similarly situated to
other sellers of natural gas. Because regulated public utilities
were required to provide gas bundled with other services —
such as serving all members of the public without

14

discrimination, “providing a firm backup supply of gas,” and
assuring continued service to low-paying customers — the
products that they solid differed from the products sold by
independent gas marketers. Gen. Motors Corp., 519 U.S. at
297, 303-04. The Court emphasized that these services
provided by the utilities “serve[] important interests in health
and safety” and that “health and safety considerations [may] be
weighed in the process of deciding the threshold question
whether the conditions entailing application of the dormant
Commerce Clause are present.” Jd. at 306, 307.

So too, here, the entity that is receiving favorable tax
treatment is an entity whose mission is furthering the public
interest of people in the taxing State. Indeed, it is the one
entity that, under our constitutional structure, is charged solely
with serving the interests of the citizens of Kentucky. The
favorable tax treatment of Kentucky bonds helps in achieving
those public interests — just as in General Motors. This would
not be the case with respect to other private and public bond
issuers. For purposes of the Commerce Clause, Kentucky is
not similarly situated to other issuers of bonds.

The manner in which Kentucky has chosen to finance state
and local government is consistent with an “essential and
patently unobjectionable purpose of state government — to
serve the citizens of the State.” Reeves, 447 U.S. at 442. The
State does not discriminate against interstate commerce when
it chooses not to finance other state governments at the same
time.

Hi. AS A SELLER OF BONDS, KENTUCKY STANDS
AS A MARKET PARTICIPANT.

The dormant Commerce Clause does not “limit the ability
of the States themselves to operate freely in the free market.”
Reeves, 447 U.S. at 437. Rather, when States act as “market
participants,” as consumers or vendors, their actions are

15

exempt from Commerce Clause analysis. Jd. at 439. It is only
when the States act as regulators that Commerce Clause
analysis is triggered.

The critical issue in distinguishing between the State as a
regulator and as a market participant is whether the provision
in question affects private trade and not the State’s own trade.
As this Court concluded in White v. Mass. Council of Constr.
Employees, 460 U.S. 204, 218 (1983), whether a State is
viewed as a market participant “should turn primarily on
whether a particular state action more closely resembles an
attempt to impede trade among private parties, or an attempt,
analogous to the accustomed right of merchants in the private
sector, to govern the State’s own economic conduct and to
determine the parties with whom it will deal.”

A State’s issuance of bonds and the tax treatment it
accords those bonds is a classic example of a State acting in its
role of market participant. When a State sells a bond, it is
entering into a contractual agreement to repay a loan over time.
The State’s covenant with the bond purchaser that it will not
tax the “swe!, in turn, is an essential aspect of that contractual
agreein:’ Jecause it directly establishes the net return the
bondholder will obtain on his investment. Accordingly,
Kentucky’s agreement to forgo the collection of state income
tax cannot be separated from its status as a seller seeking to
obtain the best possible terms for its product in the
marketplace. The Kentucky Court of Appeals’ decision
attempting to separate Kentucky’s role as a bond seller from its
role in setting the tax status for those bonds should be rejected.

Respondents mistakenly contend that this Court’s decision
in New Energy Co. v. Limbach, 486 U.S. 269 (1988), dictates
that Kentucky should not be treated as a market participant.
See Br. in Opp. 11-13. New Energy, however, is not on point.
In New Energy, Ohio provided favorable tax treatment for
purchases of ethanol only if the ethanol was produced in Ohio
or in a State that granted similar tax advantages to ethanol

16

produced in Ohio. As such, Ohio was not acting as a seller or
purchaser itself but was instead attempting to provide
economic benefit to particular private entities. Here, unlike in
New Energy, Kentucky’s tax treatment of its bonds is an
integral part of its sale of its own product. The market
participant doctrine thus clearly applies.

Ill. THE RULE ADOPTED BY THE LOWER COURT
WOULD HAVE DEVASTATING EFFECTS ON THE
STATES’ FISC AND THE BOND MARKET, AND
REFLECTS A DECISION BETTER LEFT TO
CONGRESS.

If the decision of the Kentucky Court of Appeals is upheld,
the impact upon the States’ fisc will be devastating. Moreover,
such a holding will likely destabilize the bond market. Any
change to this longstanding taxation practice is better left to
Congress, which has thus far countenanced the practice.

1. If a State’s tax system is found to be discriminatory in
violation of the dormant Commerce Clause, the State has three
options to remedy the violation: (1) refund the additional taxes
paid by the taxpayers who suffered an undue burden, (2)
retroactively impose higher taxes on those who benefitted by
the discrimination or (3) some combination of both. Fulton
Corp. v. Faulkner, 516 U.S. 325, 346-47 (1996). Although a
State could, in theory, correct past discrimination by retro-
actively imposing a higher tax on the holders of tax-exempt
bonds who benefitted by the discrimination, that option is not
realistic for most States. First, States would face significant
constitutional and political hurdles if they were to attempt to
increase retroactively taxes for tax years that are already

17

closed.’ Second, numerous States have state constitutional
provisions that preclude their legislature from taxing their own
State’s bonds.‘ Third, many States have statutory provisions
that create a covenant between the bondholder and the State in
which the State agrees, for the life of the bond, not to tax
interest arising from the bond.°

Should the decision below be affirmed, most States would
therefore be faced with refunding any taxes deemed to be
discriminatory. For some States, that liability will go back for
seven or more years. New York, which generally allows tax
refund claims to be submitted for three years following the
filing of the return, estimates that the refund claims it faces
total $200 million. Thus, States are looking at collective
liability in the billions of dollars should this longstanding state
practice be declared unconstitutional.

In addition to being subject to claims totaling billions,
States will lose a substantial revenue stream on a going forward
basis. State and municipal bonds are frequently issued for

> North Carolina, for example, cannot realistically impose a
retroactive tax on all taxpayers who held tax-exempt North Carolina
bonds during calendar year 2001 (the first tax year at issue in a
pending class action filed against the State).

* See, e.g., Ky. Const. § 171; Ohio Const. art. VIII, §§ 2k(D)(4),
2\(E), 2m(D), 2n(E), 20(G), 2p(E) (interest on state bonds “shall at
all times be free from taxation within the state”).

* See, e.g., Cal. Gov’t Code § 99016 (Deering 2007); Ga. Code
Ann. § 32-10-49 (2007); Ky. Rev. Stat. Ann. § 58.580 (West Supp.
2006); N.Y. Pub. Auth. Law § 372 (McKinney 2004); Va. Code
Ann. § 15.2-5361 (2007).

* See, e.g., Dunn v. State, 635 S.E.2d 604 (N.C. Ct. App. 2006)
(class action seeking refund for tax years 2001 and forward), disc.
review granted, 361 N.C. 351 (2007).

18

terms of up to 40 years, depending upon the nature of the
project being financed. If a State is contractually obligated to
treat previously-issued bonds as tax-exempt, that State may be
locked into exempting all bonds (both bonds previously issued
by the State and the bonds of its sister States) for the next 40
years. Thus, the existence of outstanding bond issuances may
well limit the ability of States to tax prospectively all bonds the
same. The only choice for many States may be to exempt all
bonds for decades to come. States and local governments will
then be forced to raise other taxes substantially to replace this
lost revenue.

North Carolina’s experience following Fulton illustrates
the budgetary crises that States will face should the decision
below be affirmed. In Fulton, this Court concluded that North
Carolina’s intangibles tax violated the dormant Commerce
Clause. 516 U.S. at 346-47. The Fulton decision involved a
single taxpayer who had challenged the tax. Shortly after the
Fulton decision, however, a class action was filed by a
different litigant on behalf of all taxpayers who had paid the
intangibles tax to the State. See Smith v. State, 507 S.E.2d 28
(N.C. 1998). In that action, the North Carolina Supreme Court
held that all intangible taxes collected by the State of North
Carolina from 1991 through 1994 had to be repaid by the State.
North Carolina ultimately paid $586 million in settlement of
the class action. The combined effect of repaying this sum and
losing a significant revenue stream contributed to a state
budgetary crisis that required the Governor to declare a state of
fiscal emergency. Chnstopher Kirkpatrick, Easley Declares
Fiscal Emergency, Durham Herald Sun, Feb. 9, 2001, at Al.
Over a decade after the Fulton decision, the State of North

i9

Carolina remains in litigation over the emergency measures
that were taken to keep the doors of State government open.’

2. If the decision of the Kentucky Court of Appeals is
upheld, the bond market will also be substantially impacted.
See Noonan, supra, at 969 (noting upheaval that will occur in
bond market). Bondholders face a risk of substantial
devaluation of their bonds, particularly bonds issued by States
with high state income taxes.’ Individuals who hold such
bonds may see the market value of their assets decline. See
Denison, supra, at 10. Moreover, such losses will cause many
investors to be less inclined to make future purchases of
municipal bonds.

3. Respondents are asking this Court to dramatically alter
how the States have taxed bonds for the past hundred years.
Such a change is best left in Congress’ hands. “The
Constitution gives that branch of government [Congress] the
power to regulate commerce among the states, and until it acts
. . . we should enter the field with extreme caution.” Gen.
Motors, 519 U.S. at 310 (quoting Northwest Airlines, Inc. v.

” See Goldston v. North Carolina, 637 S.E.2d 876 (N.C. 2006)
(challenge to Governor’s emergency appropriation from State
Highway Trust Fund); see a/so Coley v. State, 631 S.E.2d 121 (N.C.
2006) (challenging mid-year increase of state income taxes); County
of Cabarrus v. Tolson, 610 S.E.2d 443 (N.C. Ct. App. 2005)
(challenging Governor’s emergency appropriation of funds originally
earmarked for loca] government).

* Although many States will not have the option of retroactively
taxing bonds that were originally issued as “tax-exempt” by the
State, the remedy that is ultimately implemented in each State must
be determined, as an initial matter, by state legislatures and state
courts. Until the specific remedy becomes settled for each State, the
uncertainty as to whether States may tax all bonds will significantly
depress the value of “tax-exempt” bonds.

20

Minnesota, 322 U.S. 292, 302 (1944) (Black, J., concurnng));
see also Quill Corp. v. North Dakota, 504 U.S. 298, 318 (1992)
(concluding that burden on interstate commerce is “not only [a
determination] that Congress may be better qualified to
resolve, but also one that Congress has the ultimate power to
resolve”).

This is especially true where Congress has long been
aware of a common state taxing practice and has taken no
action to forbid it. As this Court observed more than 125 years
ago, “[t]he long continued silence of Congress, with its plenary
power, in the presence of . . . [state legislation] is itself an
implied ratification and adoption, and is equivalent in its
consequences to an express declaration to that effect.” Wilson
v. McNamee, 102 U.S. 572, 575 (1880); see also Gen. Motors
Corp., 519 U.S. at 305 (concluding that Congress’ failure to
alter a longstanding state practice indicates that Congress
believes the practice to be “within the realm of what the States
may reasonably promote and preserve”). That 1s exactly the
situation here. Although Congress has carefully studied the
States’ longstanding practice with respect to the exemption of
interest earned on government bonds, it has chosen not to alter
or ban it.

For example, in 1959, Congress directed both the
Committee on the Judiciary of the House of Representatives
and the Committee on Finance of the Senate to make a full and
complete study of “all matters pertaining to the taxation by the
States of income . . . from the conduct of business activities
which are... a part of interstate commerce.” Pub. L. 86-272,
§ 20), 75 Stat. 555, 556 (1959). The resulting reports of the
Spec'a! Subcommittee on State Taxation of Interstate
Commerce were presented to Congress in 1964 and 1965. The
Subcommittee sought to identify “the conflicts between the tax
policies of the States and the national policy of assuring the
free flow of commerce.” Special Subcommittee on State
Taxation of Interstate Commerce, Committee on the Judiciary,

21

House of Representatives, State Taxation of Interstate
Commerce, H.R. Rep. No. 88-1480, at iii (1964).

In its report, the Subcommittee detailed the practice by
States of exempting their own bonds from taxation, while
taxing the bonds of other States. H.R. Rep. No. 88-1480, pt. 2,
at 258-59 (1964). The report expressly listed the States that
engaged in this practice and those that did not. Jd. at 259, H.R.
Rep. No. 88-1480 app. L at A371-A433 (1964). The report,
however, did not identify the taxation of bonds as an area of
conflict between State and national policy. The study therefore
made no recommendation of change in this area. Rather, the
study made the general recommendation that States “should be
as free as possible to pursue their own tax policies even though
they are at variance with the Federal policy.” H.R. Rep. No.
89-952, pt. 6, at 1159 (1965). Congress made no effort to
change taxation of state and local bonds after receiving the
Subcommittee’s report.

On numerous other occasions, Congress has been made
aware that most States exempt their own bonds from state
taxation while taxing the bonds of other States. See, e.g., H.R.
Rep. No. 91-413 (1969), reprinted in 1969 U.S.C.C.A.N. 1645,
1825 (“State and local governments generally do not directly
tax interest on Federal bonds, but they tax the interest income
on bonds issued by other States.””); S. Rep. No. 91-552 (1969),
reprinted in 1969 U.S.C.C.A.N. 2027, 2253 (noting state
practice of taxing bonds of other States). Thus, Congress is
well aware of, and has carefully studied, this practice. Its
failure to act strongly supports the practice’s validity under the
Commerce Ciause.’

* Another indication of Congress’ at least implicit approval of the
practice is its actions with respect to Hawaii. In 1901, the United
States territory of Hawaii began exempting its own bonds from
taxation while taxing the bonds of the States and other territories.

xe ek *

The decision of the Kentucky Court of Appeals interferes
with a fundamental aspect of state sovereignty — the ability of
States to determine the most appropriate means of raising
revenue in order to provide for the common good. Principles
of state sovereignty counsel that this Court should exercise
restraint in restricting the manner in which Kentucky
undertakes to sell its bonds. See Reeves, Inc. v. Stake, 447 U.S.
429, 438 (1980). Federal solicitude for the States’ power to
manage their debts goes back to the founding of the Republic.
See, e.g., the Federalist No. 81 (Alexander Hamilton)
(Arlington House 1965); accord Boston Stock Exch. v. State
Tax Comm'n, 429 U.S. 318, 328 (1977) (“The Commerce
Clause does not... eclipse the reserved ‘power of the States to
tax for the support of their own governments.’”) (quoting
Gibbons v. Ogden, 22 U.S. 1, 199 (1824)). Kentucky’s
legislature should be permitted to determine whether it makes
good economic sense for the State to forgo payment of taxes on
Kentucky bonds in order to obtain more money now (and better

1901 Hawaii Sess. Laws 31-32. Although Congress had clear
authority to override this practice, it did not do so. See U.S. Const.
art. IV, § 3, cl. 2; Nat'l Bank v. County of Yankton, 101 U.S. 129,
133 (1880). In fact, during the 59 years that Hawaii was a territory
of the United States, the tax exempt bonds that Hawaii issued were
expressly approved by Congress and the President of the United
States. See, e.g., 31 Stat. 161 (1900) (Hawaii Organic Act) (bond
issuances to be approved by the President); 66 Stat. 133 (1952)
(Congressional approval! of Hawaii bond issuance). Moreover, when
Hawaii was ultimately admitted into the Union, Congress recognized
that Hawaii's territorial laws (which at the time included tax
exemption for Hawaii bonds but not other States) “shall continue in
force.” 73 Stat. 4, 11 (1959).

23

financing terms) to build schools, hospitals and roads. The

dormant Commerce Clause does not require that this choice be

taken out of the hands of Kentucky’s elected officials.
CONCLUSION

The judgment of the Kentucky Court of Appeals should be
reversed.

Respectfully submitted,
ROY COOPER
Attomey General of North Carolina

Christopher G. Browning, Jr.*
Solicitor General of North Carolina

Kay Linn Miller Hobart
Special Deputy Attorney General

Gregory P. Raney
Assistant Attorney General

Counsel for Amici Curiae

July 19, 2007 *Counsel of Record

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0507%3A17. Public record. Not legal advice.